Kontoor Brands, Inc. — Form 10-Q Summary
Period: Quarter ended June 29, 2019; six-month comparison with the period ended June 30, 2018. The request metadata says “2018 Q2,” but the filing is for Q2 fiscal 2019.
Business context and reporting period
Kontoor designs, markets and distributes apparel primarily under Wrangler and Lee, and also operates the VF Outlet business. VF completed the spin-off on May 22, 2019; Kontoor began trading separately on May 23. The 2019 quarter combines results through the separation date prepared on a carve-out basis with standalone results thereafter. Prior periods are carve-out results, so comparisons—particularly for expenses, financing and balance-sheet items—are not fully comparable.
Financial performance and position
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Revenue | $609.7m | $663.9m | $1,258.1m | $1,333.5m |
| Operating income | $53.5m | $75.7m | $78.7m | $168.1m |
| Net income | $38.0m | $60.5m | $53.4m | $140.2m |
| Diluted EPS | $0.67 | $1.07 | $0.94 | $2.47 |
| Gross margin | 38.6% | 40.2% | 38.4% | 41.6% |
| Operating margin | 8.8% | 11.4% | 6.3% | 12.6% |
Q2 revenue fell 8%, operating income 29% and net income 37% year over year. For the six months, revenue fell 6%, operating income 53% and net income 62%. At June 29, cash was $76.7m; inventory was $538.2m. Debt carrying value was $987.2m, including $7.5m current and $979.7m long-term. The $500m revolving facility had no borrowings and $498.7m available after standby letters of credit; the company reported compliance with its covenants. Total equity was $82.2m.
Six-month cash from operations was $580.2m, investing cash flow was $509.7m, and financing cash flow was negative $1,111.0m; cash declined $20.1m to $76.7m. These cash-flow figures were materially affected by separation-related settlements: operating cash flow included a $548.3m change in amounts due from the former parent, and investing cash flow included $517.9m repayment of notes receivable from VF. They should not be read as ordinary recurring cash generation.
Material changes versus the prior comparable period
- Q2 revenue declines reflected weaker Wrangler and Lee sales, a major U.S. retailer bankruptcy, exits from underperforming markets, business-model changes and a 1% unfavorable foreign-exchange impact. International revenue fell 25%; branded direct-to-consumer revenue fell 7%, although U.S. digital sales through owned sites grew 15%.
- Gross margin contracted 160 basis points in Q2 and 320 basis points for the six months. Management attributed pressure to business-model changes, restructuring and separation costs, distressed sales and adverse product costs. These initiatives and costs reduced Q2 gross margin by about 140 basis points and six-month gross margin by about 220 basis points.
- Q2 SG&A was 29.9% of revenue versus 28.8%; for the six months it was 32.1% versus 29.0%. Management said separation, restructuring and business-model changes added about 220 and 300 basis points, respectively, partly offset by expense control.
- Six-month segment profit declined to $80.6m for Wrangler from $130.6m and to $31.4m for Lee from $54.1m. Segment margins fell to 11.0% from 17.1% for Wrangler and 7.0% from 11.3% for Lee.
- Kontoor raised $1.05bn of third-party debt to fund primarily a cash transfer to VF. Interest expense rose to $7.6m in Q2 from $0.4m and to $7.7m for the six months from $0.8m.
Outlook, management commentary, risks and unusual items
No quantified revenue or earnings guidance is provided in the supplied filing text. Management’s stated priorities include pursuing growth in non-U.S. wholesale and branded direct-to-consumer while maintaining focus on U.S. wholesale, and continuing efficiency and cost-saving initiatives. The company expects these initiatives to reduce future operating costs, but does not quantify anticipated benefits.
- Restructuring charges were $24.6m for the six months, including severance, impairments, inventory write-downs and other costs; $12.8m remained accrued at June 29 and was expected to be paid within 12 months. The company cited closure of three owned Mexican manufacturing facilities, market exits, a CASA distributor-model transition and organizational changes.
- The new secured credit facilities comprise a $750m Term Loan A, $300m Term Loan B and $500m revolver. Effective annual interest rates at period-end were 4.3% and 6.8% for the term loans, respectively. The filing warns that debt may constrain strategy and increase financing costs.
- Subsequent to quarter-end, the board declared a first quarterly dividend of $0.56 per share, payable September 20, 2019. Future dividends remain subject to board approval, financial condition, cash flow, debt covenants and other factors. The company also entered into an interest-rate swap after quarter-end.
- Key risks include separation disruption or loss of expected benefits, foreign-exchange movements, consumer demand, dependence on major customers, input costs, competition and margin pressure, supply-chain and information-security disruption, and tax, legal and geopolitical developments. Management said ordinary-course claims and lawsuits were not expected to have a material adverse effect; no material changes to previously disclosed risk factors were reported.
- Six-month effective tax rate was 29.0% versus 18.0%; differences included discrete tax items and, absent those items, unrecognized tax benefits on certain pre-separation CASA losses. Potential Swiss tax-law effects could be significant, but the filing said the impact could not yet be determined.
Most important facts for investors to verify
- How recurring standalone cash generation and working-capital needs compare with the reported cash flows, which include substantial VF settlement activity.
- Whether revenue, margins and segment profitability stabilize after the retailer bankruptcy, international market exits and other business-model changes.
- Progress and costs of restructuring, separation and standalone operations, including whether expected savings are realized.
- Debt repayment capacity, interest-rate exposure, covenant headroom and the sustainability of the declared dividend.
- Tax exposures and the eventual effects of Swiss tax legislation, as well as foreign-exchange and customer-concentration risks.